DRIP Investor - All about DRIPs
Dividend Reinvestment Plans (DRIPs), offered by about 1000 companies and closed-end funds, are programs which allow current shareholders to purchase stock directly from the company, bypassing the broker and brokerage commissions. Investors purchase shares with dividends that the company reinvests for them in additional shares. Most DRIPs also permit investors to make voluntary cash payments directly into the plans to purchase shares.
DRIPs have many attractions for individual investors:
Most companies charge no commissions for purchasing stocks through their DRIPs, and those that do charge only a nominal fee.
More than 100 companies have DRIPs which permit participants to purchase stock at discounts to prevailing market prices. These discounts are usually 3 to 5 percent and may be as high as 10 percent.
Most DRIPs permit investors to send optional cash payments (OCPs), in many cases for as little as $10, directly to the company to purchase additional shares. If your investment isn't enough to purchase a whole share, the company will purchase a fractional share, and the fractional share is entitled to that fractional part of the dividend. OCP gives small investors the ability to buy attractive blue-chip stocks when they otherwise might not be able to afford them.
Joining a DRIP is easy. Once you have selected a particular stock, check to see if it has a DRIP. This directory is an updated version of the one that appears in my best- selling book, Buying Stocks Without A Broker (available in bookstores or by calling 1-800-233-5922). Also, contact the shareholder relations department of the company of interest to verify that it has a DRIP.
Once you have identified a company with a DRIP, in most cases you have to become a shareholder of record to enroll. This is an important point. You must have the stock registered in your name, not brokerage or "street" name.
Once you are a shareholder of record, contact the company for a DRIP application and prospectus. The prospectus provides all the details about the program, including fees, if any; optional cash payment minimums and maximums; investment dates; and eligibility requirements. Chances are, the company will probably contact you once it has your name as a registered shareholder.
Although DRIPs are fairly straightforward investments, investors should be aware of the following nuts and bolts:
Many DRIPs do not charge any fees to participate. However, there is a trend developing in the industry toward the implementation of fees for purchasing shares through the plans. For example, Bristol-Myers Squibb charges a fee of 4 percent of the dollar amount of dividends being reinvested (maximum $5 per transaction). The firm also charges 4 percent of the amount invested via optional cash payments (maximum of $25). It is important that you know what the fees are before joining the DRIP.
Know the number of shares needed to enroll in the DRIP. Most plans require only one share. But Bristol-Myers Squibb, for example, raised its minimum to 50 shares. Since it costs money to service DRIP investors, it's not surprising that companies are raising their minimums in order to weed out those individuals whom they feel are "marginal" investors. Check with the company beforehand concerning share requirements for enrollment so there are no surprises when it comes time to join the program.
DRIPs differ between companies. Some DRIPs purchase stock with optional cash payments once a month, while others do so once a quarter or even once a week. The timing of purchases may differ. Some firms buy on the first business day of each month, while others purchase stock on the 15th of each month. Some DRIPs permit investors to take possession of some of their dividends and reinvest the remainder, while others require that all dividends are rein vested. Some programs allow individuals to make optional cash payments without reinvesting dividends, while others do not. How do you find out the particulars? Call the company, talk to the shareholder relations department, and get a copy of the plan prospectus. Eligibility requirements and fees, if any, are highlighted in this directory.
Dividends that are reinvested for additional shares are still considered income for tax purposes. The 1099 form that you receive from the company each year gives you this information. Also, DRIP investing requires maintaining good records, especially to determine the cost basis of stock for tax purposes when it comes time to sell. Companies and their transfer agents provide regular statements which help investors keep track of the DRIP holdings. Investing in DRIPs limits your flexibility to some extent. For example, shares are purchased usually once a month. Let's say you like a stock at today's price. By the time the stock is purchased with your optional cash payment, the stock may have risen in price. The ability to transact a buy with the speed that is possible through a broker is lost in a DRIP. The same is true on the sell side, when it may take five to ten trading days for a sell transaction to be con- ducted. That's why the programs are suited for long-term investing and not trading. Over time, fluctuations in price should even out and not have much of an impact on your portfolio's performance.
A potential stumbling block to joining a DRIP is that in most programs you already have to be a shareholder of the company in order to enroll. Brokers offer one avenue for getting that first share, although the fees to purchase one share of stock will be quite high in percentage terms of the total investment. However, investors should realize that once the initial investment is made through the broker, they will never need a broker again to purchase stock in that company. One discount brokerage firm with reasonable fees for small purchases and does not charge to forward you your stock certificates is Mydiscountbroker.com (1-888-882-5600).
Another way to get the first share is by going directly to the company for initial purchases. These companies, which we call No-Load Stocks, come in two types: those which are open to all investors and those which are open only to corporate customers or residents in the state or states in which the company operates.
Investing in No-Load Stocks is as easy as investing in no load mutual funds. All it requires is calling or writing the company and requesting information and an application. Once the information is received, investors merely have to fill out the application form and return it to the company along with their check for the initial investment. Some No-Load Stocks have initial investment minimums of as little as $50. Following the initial investment, investors may make additional purchases with optional cash payments and reinvested dividends. In most cases, the companies charge no fees for these services, and those that do have only nominal fees.
While investors benefit greatly from direct-purchase programs, benefits also flow back to the companies. Direct-purchase programs help solidify relations with shareholder, which can translate into supporting company management and buying more of the company's products. Direct- purchase programs are effective ways to raise equity capital cheaply. Many no-load stocks are utilities -- traditionally heavy users of capital. When utilities sell stock directly to customers, they are, in effect, underwriting their own stock offering. Issuing shares in this manner is considerably less costly than using an investment bank to float a secondary stock offering. Also, selling stock directly to utility customers turns a ratepayer into a shareholder, which can be helpful when it comes time to seek higher utility rates.
The fact that high-profile companies, such
as McDonald's, Procter & Gamble, Exxon, and Texaco, have
direct-purchase programs has fueled interest in these programs from both
investors and corporations. Given the benefits companies derive from
direct-purchase programs, it's a good bet that more companies will start
direct- purchase plans.
Investors may also obtain the first share via the "buddy system." For example, let's say that someone you know has stock in Walgreen. You can go through Walgreen's transfer agent to have your friend transfer one of his or her shares into your name. After the transfer, you are now a share- holder of record and able to participate in the DRIP.
A variation of the buddy system is getting perhaps five investors together to purchase a total of five shares in a company. Splitting up the brokerage commission on a five- share investment makes each investor's commission relatively small. Following the purchase, go through the transfer agent and have the five shares transferred into the individual names of the five members of the group. Once this is done, each investor may enroll in the DRIP and begin making investments with reinvested dividends and optional cash payments.
The most obvious benefit of DRIP investing is the ability to buy shares without paying brokerage fees. However, I believe that the biggest benefit is that the programs allow anyone, including small investors, to participate in the stock market. Many individuals wrongly believe that the market is a rich person's game, especially if you want to buy expensive blue-chip stocks. In fact, any investor can begin a stock accumulation program in hundreds of quality stocks via dividend reinvestment plans. Indeed, it's not a stretch to call DRIPs the most powerful investment tool available to small investors.
Companies provide a variety of options within their dividend reinvestment plans which increase the flexibility and usefulness of the programs. Many of these features are highlighted in this directory. For example, let's say you'd like to reinvest some of your dividends but would like to take possession of some as well. Many companies offer partial reinvestment, which allows you to receive some dividends and reinvest the remainder.
For investors who need the dividend income but would still like to make optional cash payments, many companies provide an "OCP-only" option in their DRIPs.
Certificate safekeeping services are another DRIP related perk. Many companies with DRIPs allow investors to send certificates to the company for safekeeping. Most companies don't charge for this service, and those that do usually have fees of only $5. Safekeeping services alleviate the need to pay for a safety deposit box in order to hold stock certificates. Such services eliminate the possibility of lost or stolen stock certificates.
Dividend reinvestment plans are perfect for long-term investing, which make them perfect for an individual retirement account. Unfortunately, it's difficult to hold DRIPs in an IRA. In order to have stocks in a self-directed IRA, you have to have a custodian for the account. Brokerage firms, which are the custodians for many self-directed IRAs, usually won't offer custodial services for an IRA with DRIPs since they don't get commissions each time stock is purchased in a DRIP. Other custodial agents, such as banks, may provide such services, but their numbers are extremely low.
Fortunately, a growing number of companies have implemented DRIPs with an IRA option. For example, Exxon offers an IRA with its DRIP. If a company offers an IRA option, it will be listed in the plan specifics.
An attractive service offered by a growing number of DRIPs is electronic funds transfer from shareholders' accounts. For example, DQE has made monthly optional cash investments easy by providing automatic supplemental contributions via direct funds transfer from a participant's bank account. Exxon is another company with an automatic investment service.
Some DRIPs make it easy to give stock as gifts. Exxon's program has a gift-giving feature, as does Texaco's. Under Texaco's program, you can open an Investor Services Plan account in a person's name, and the company provides you with a gift certificate to give the recipient.
Even if a company doesn't have a formal "gift-giving" feature to its DRIP, it's easy to give shares as a gift by transferring one of your shares to the individual.
Dividend reinvestment plans not only save you money when you buy stock, but also when you sell. Most DRIPs permit investors to sell stock directly from the plan, and the fees for selling are usually much lower than you'd pay by going through a broker. That's because the company sells shares in bulk and gets volume discounts unavailable to small investors. In a few DRIPs, it is even possible to sell stock through the company without paying any brokerage commission.
A number of foreign companies offer DRIPs, providing U.S. citizens an easy and inexpensive way to invest in foreign stocks.
Historically, overseas investing was pretty much the private domain of institutional investors with access to foreign exchanges. However, that situation has changed with the growth of American Depository Receipts, better known as ADRs.
ADRs are issued by U.S. banks against the actual shares of foreign companies held in trust by a branch or correspondent institution overseas. Oftentimes, ADRs are not issued on a share-for-share basis. Instead, one ADR may be the equivalent of five or ten ordinary shares of the company.
ADRs have become popular in recent years. One reason is convenience. Investors can buy and sell ADRs like ordinary shares, eliminating the need for currency translations. Commissions to purchase ADRs are smaller than would be charged if the securities were purchased on foreign markets.
Although ADRs offer plenty of pluses for investors, there are some things to consider before investing. Currency fluctuations will impact ADRs. When local currencies strengthen versus the dollar, the return on the ADR is boosted. Thus, if you own shares in a country whose stock market is rising and whose currency is strengthening against the dollar, you're getting a double-powered boost to your portfolio. Conversely, if the dollar is strengthening against the nation's currency of your ADR, returns will suffer. Another consideration is that accounting norms differ between countries. Thus, interpreting financial data may be difficult.
A number of quality foreign companies offer DRIPs for U.S. investors. This is an interesting way to accumulate stock in overseas firms. The following table lists ADRs, representing several countries, which offer DRIPs.
Investors who are interested in DRIPs of foreign securities should first obtain prospectuses.
Of course, just because a company offers a DRIP doesn't make it a good investment. The bottom line with any investment is the quality of the firm's financial position, prospects for earnings growth over the next several years, dividend-growth potential, and the strength and defensibility of its industry position. These factors need to be assessed before buying any investment. Chances are, with about 1000 companies offering dividend reinvestment plans, at least a few of the companies that survive your investment- selection process will offer DRIPs.
Investors who desire regular coverage of the DRIP field should subscribe to DRIP Investor. The newsletter, published by Horizon Publishing Company and written by Charles B. Carlson, CFA, has a special focus on new DRIP plans as well as new "no-load stocks." A one-year subscription for the monthly newsletter is $74 per year and may be ordered by calling 1-800-233-5922, or by clicking here.
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